Financial experts offer ideas for how to successfully teach your children about money. Letting them make spending mistakes is one of them.
CORRECTED: Merrill Edge provided the age-progression simulation. The provider was misidentified in an earlier version of this story.
Parents are understandably freaked out by their kids' incompetence when it comes to all things financial. Surveys show that half of Americans age 18 to 34 couldn't come up with $2,000 for an emergency, and only 14.6 percent of college students with credit cards know their interest rate.
Few states have comprehensive personal finance as part of their public school curriculums — so there's no need to write a letter to your congressman. An October overview study that will be published in Management Science looked at 201 studies of financial literacy education programs and found that, in general, they're worthless. A student who takes a financial literacy course is not significantly more likely to make good financial decisions than a kid who skips class to watch "Family Guy."
When it comes to getting your kids to care about money, actions, it seems, can speak louder than words.
"It's taboo to say, but education alone is one of the least effective ways of changing behavior," said Ramit Sethi, author of "I Will Teach You to Be Rich." "When it comes to money for young people, focus on modeling behavior. For example, ask anyone what they learned from their personal finance teacher. They won't remember a thing! But if you ask what they learned from watching their parents deal with money, the connections are very real and emotional."
One of the most important things a parent can do is instill a vaguely paranoid, Marx-inspired distrust of the financial services industry in their children. That mindset can help them question and avoid unnecessary bank fees, credit card debt and private student loans.
For more concrete advice, top experts in behavioral finance offer this advice on how parents can help their children to financial success:
Age progression software
One study found that participants who were exposed to a virtual reality experience — using age progression software that projects their virtual selves into the future — chose to allocate twice as much to their retirement accounts as the control group that did not use the software. The theory behind the results? Most young people view their future selves as different people — so saving for retirement seems a lot like giving money to strangers. Once students or recent college graduates have income to make retirement savings possible, it's worth walking them through this Merrill Edge-provided simulation.
Incentives instill habits
New York University professor Hal E. Hershfield said parents can beat the low odds of most efforts at financial education by tying incentives with positive financial habits. Rather than explaining compound interest, give kids more money when they save money — and less money if they don't. "One of the rules for continuing to get an allowance might be that each week they save a portion of it," Hershfield said. "It's about trying to instill an attitude of saving some of the money we get each week for later," he said.
Let your kids make mistakes
It's tempting to talk youngsters out of financial mistakes. But when the stakes are low enough with no serious lasting consequences, let children screw up financially, said Brigitte C. Madrian, a professor who specializes in behavioral economics at Harvard's Kennedy School of Government. "And they don't learn from their mistakes once," Madrian said. "Don't stress out when your kid makes stupid money decisions. Just figure they're learning, and engineer the environment so those decisions aren't huge. Let them make small mistakes and then as they show that they're learning, let them make larger mistakes."
For Madrian, that meant letting her teenage daughter spend $20 on a cheap Roomba vacuum knockoff. Madrian knew it wouldn't work and was tempted to tell her — but instead let her learn firsthand the importance of checking product reviews on electronics before buying. The same thinking, she said, should apply to overdraft fees and other first-time banking mishaps. Save the helicopter parenting for big financial decisions that have the potential for long-term damage.
Level with your kids about your own challenges and mistakes
It might be hard, but sharing tales about screwups and difficulties committed by adults — past and present — can help them see the consequences of financial inattentiveness. Even if you aren't especially good with money, kids can still learn from mistakes — just as an alcoholic can show the perils of alcohol abuse. Discussing even the most mundane elements of financial planning can also get them thinking about the trade-offs that come with every financial decision. "What does that new car cost? How much of mom's salary per year will it cost to go to Hawaii?" said Carl Richards, a financial planner and the author of "The Behavior Gap." "Is it worth it for her to be gone three nights per week to make that trip work?" These kinds of frank conversations about adult financial decisions can be more effective than responsibility lectures.
Provide limited amounts of information tied to action
Financial literacy programs that are the least effective are those that take a broad, personal finance 101 approach, said Madrian of Harvard's Kennedy School of Government. Providing specific, just-in-time training when youngsters are about to make key decisions will lead to better outcomes.
—By Zac Bissonnette, Special to CNBC.com
Follow him on Twitter @ZacBissonnette
First published November 19 2013, 2:29 PM